Mortgage Lending Rules In Canada Continue To Tighten

On 6/21/2012 several changes to mortgage lending rules that are aimed to address the high level of household debt in Canada, were outlined by Finance Minister Jim Flaherty.

• The maximum amortization period for a mortgage with government-backed mortgage insurance (through Canada Mortgage and Housing Corporation, CMHC) has decreased to 25 years from 30 years.
• The maximum amount that can be borrowed against a home has decreased to 80% from 85% of a home’s equity (market value).
• The maximum gross debt service ratio limited to 39%. The maximum total debt service ratio limited to 44%.
• Government-backed mortgage insurance available only to real estate with purchase prices under $1 million.

The changes which take effect on 7/9/2012 will directly impact those who are seeking highly leveraged mortgages. In Canada, buyers with a down payment less than 20% (of the value of the home) are required to purchase government-backed mortgage insurance through (CMHC). The changes make it difficult to obtain a highly leveraged mortgage amortized over a period longer than 25 years, as they would no longer qualify for the government-backed mortgage insurance. The changes will also impact those who intend to borrow large sums of money against the equity in their home through home equity lines of credit (HELOC).

This will help to reduce speculative real estate investments by those who dabble in the real estate market. Many cannot reasonably afford the investment property and therefore have been seeking highly leveraged mortgages or HELOCs on their principle residence to make the purchase. Of particular note has been the condominium markets in the GTA and GVR.

New buyers would qualify for smaller mortgage amounts, which will likely translate into a difference of tens of thousands of dollars. As a result, a home purchase (both condo and low-rise) may be out of their reach.

The rules will likely not affect those who do not use highly leveraged mortgages. More buyers may become priced out of the market (difficulties qualifying for highly leveraged mortgages), while others will purchase homes that are more in their price range. This may slow buying/selling activity and cool the real estate market. Properties in moderate demand areas may take a bit longer to sell. The impact in certain areas of low supply within the Greater Toronto Area and Greater Vancouver Region may less, and housing prices are likely not decrease much or at all in those pockets of the city.

Assessment & Recommendations

The changes should have really come sooner, and I still think they do not do enough to curb the extremely high ratio of household debt to disposable income in Canada, which has continued to rise to 152%! This is despite years of warnings from Bank of Canada governor Mark Carney. The last time I wrote about changes to mortgage lending rules (January 2011) the ratio was 144% . In more popular metropolitan areas the average home prices have continued to rise significantly in the past few years, but increases to income levels have lagged behind. Combined with the threat of the global slowdown, current employment levels, household debt remain a large concern and risk to the economy.

It is expected that and debt levels will remain stubbornly high in Canada for the foreseeable future. It is also likely that credit will continue to tighten which will include more rule changes as well as eventual retail bank interest rate increases.

My recommendation for home purchasers remain unchanged: If you are a home purchaser (whether first time or not), I seriously recommend ensuring you can put down at least 25% of your home’s equity, while having a reasonably sized emergency fund, and being comfortably able to support the mortgage if the rates were to increase by another 1-2%. When your financial situation allows you to afford a home priced higher, it would be more suitable to do so at that time instead. Starting out at affordable levels will help to avoid any large financial mistakes, which would create a huge financial setback. This is risk management 101 for the average individual.

For real estate investors: The principle is the same for making real estate investments. Don’t forget low risk does not mean low reward, and leverage amplifies both losses & profits. The changes signal that the market needs to be cooled, which indicates that prices are likely to be overvalued. Real estate investments at current market prices (and rent levels), may not yield profitable returns.

I’m a private investor based out of Canada, who developed the “function-centric investing” paradigm. I am an investor who blogs a little here and there, rather than a blogger who invests a little here and there. I'm passionate about investing and sharing investment knowledge!

1 Comment

Tricia

June 25, 2012

In situation when debt of Canadian households is at record highs considering recent years, it needs to be added there are several benefits, e.g. it has an influence over housing market. I really think we should expect higher quality of mortgages while avoiding the risk of housing bubble that has been forecast by those who see similarities between current real estate prices in Canada and situation in the U.S. before year 2009.